problems 20-9 the federal government increases spending on national defense on the golliwing graph indicate the...

problems 20-9 the federal government increases spending on national defense on the golliwing graph indicate the short run and long run effects of this change on the evonomy assuming policy makers take no further

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Expert Solution

Intially, the economy is in equilibrium at Point E.

SHORT - RUN EFFECT:

A rise in the federal government spending on the national defense increases the flow of money into the economy. This will increase the purchasing power of the people inducing them to increase their demand for goods and services. This will increase the aggregate demand and consequently the AD shifts to the right from AD1 to AD2.

The new equilibrium is at point E1 where both output and prices are higher.

LONG-RUN EFFECT:
In the long run, in order to re-store the equilibrium at full potential level of output, the AS curve shifts to the left from AS1 to AS2 so much so that it intersects the New AD and the LRAS curve at point E2.

The economy is back to the potential level of output with more inflation.

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Rahul Sunny answered 1 year ago

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